Friday, October 13, 2006

More Records

EUR/USD 1.2521 Hi 1.2578 Low 1.2510
USD/JPY 119.59 Hi 119.69 Low 119.07
AUD/USD 0.7502 Hi 0.7535 Low 0.7499
EUR/JPY 149.76 Hi 150.20 Low 149.63

Well the Karl Rove election strategy doesn't seem to be going to plan. Although the Dow Jones just hit ANOTHER record high, George W. Bush's approval ratings just hit a record low. According to a recent Newsweek only 33% of Americans approved of Bush. Obviously these guys don't know when they have it good. But there are still 3 weeks and one FED RESERVE board meeting to get through before the November 7 election, so don't write off Karl Rove's October economic surprise quite yet. Although the Foley surprise seems to be getting slightly more press right now. The U.S. votes in the right to torture and you hear not a peep out of the electorate but a few salacious e-mails and VABOOM, catastrophe hits the Republican re-election strategy. The Puritan heritage is alive and well and living in America.

Meanwhile the fabulously competitive U.S. economy just hit another milestone: another record Trade Deficit. In August the U.S. recorded a USD 69.9 billion deficit. There were record deficits in the U.S. Trade with China, Mexico and OPEC. Analysts have been quick to seize on the OIL component and point out, helpfully, that OIL prices have since declined. The idea is that this should go some way to reducing America's Trade Deficit in the months ahead. It's not a lot to hang your hat on, but then you go with what you've got. As a result of America's appetite for imports, GDP growth for the 3rd quarter is likely to be a bit soft. Forecasters are calling for an GDP annual growth rate of sub 3%.

While OIL supposedly took the shine off the U.S. Trade performance, Japan managed to record a 36% year on year increase in its Trade Surplus in August. Its Current Account Surplus was up 22.2% year on year. So I guess when cheaper OIL prices hit the Japanese accounts the results will be even more spectacular. Similarly, China recorded its second larges Trade Surplus on record. So global imbalances are as large as ever. The only question is: how will this be fixed? The Plaza Accord led to the bubble economy in Japan via very, very low domestic interest rates, a subsequent economic crisis when the bubble burst and a long, slow economic recovery. And with USD/JPY substantially lower than Pre-Plaza the U.S. still hasn't got anywhere with its Trade Deficit. In fact things are now worse.

Indeed, U.S. economic fundamentals are unimpressive all round. Yesterday's FED's Beige Book was similarly uninspiring. Though there was no sign of a uniform slow down in activity, except in the Residential Housing market, which is in trouble pretty much across the country. It is the bursting of the Housing Market bubble which is keeping analysts up at night. Given that the boom in the residential housing gave a huge boost to economic growth in the first part of this decade, it is fair to assume that the bursting of the housing bubble will resonate for a while. That's what everyone is waiting for. Talk of RECESSION has eased somewhat recently, but market watchers are STILL waiting for second round effects.

Yesterday's Trade numbers took the edge off the USD but the market remains broadly bullish USD. The focus, of course, is interest rate differentials and low volatility. The whole Carry Trade phenomenon needs low volatility to continue. If that cracks, and let's face it it has cracked in other markets, then all bets are off. The Carry Trade favourite, USD/JPY looks like it will be capped below 119.80. This morning BoJ officials helpfully suggested that the official cash rate has room to move higher before the end of this year. EUR/JPY is playing around with record highs but keeps seeing good offers above 150.00, so sell the rally remains the way to go. EUR/USD, despite the positive economic fundamentals in the EuroZone and the constant hints of higher rates from Trichet and his buddies, is struggling to make gains. Some of this is related to EUR/JPY selling by Central Banks but ultimately, the EUR/USD bull run will be part of the USD bear story. Unless the EUR/USD sustains a break below 1.2500 a buy the dip strategy is recommended.

OIL 58.87
GOLD 586.20

The correction in the GOLD price longed for by the USD bulls appears to be over. With China currently sitting on USD 988 billion in Foreign Exchange Reserve (and rising) and looking to diversify away from the USD, particularly given the pressure coming from the U.S. for a Chinese currency revaluation, the upside potential for GOLD looks strong. According to some reports the proportion of reserves held in GOLD by Central Banks is around 9% of total reserves, with China and Japan holding considerably less than 9% of their reserves in GOLD. A real shift towards holding GOLD as a reserve asset, even without a substantial USD depreciation, would light a fire under GOLD. For now, GOLD is still in range trading mode, albeit with a bullish tone. A sustained break above USD 600 would be positive for the market.

OIL remains bid on the back of rumours of OPEC agreements. Indeed, the whole Commodity Market sell off appears to be running out of steam. We have triggered the stops and seen a healthy correction, provided growth remains relatively strong in Asia and the EuroZone, then Commodity price gains are possible from here. The U.S. economy may be heading for recession but the spill over effect on other economies, thus far, has been limited.

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Wednesday, October 11, 2006

Alternative Statistics for Alternative Realities

EUR/USD 1.2550 Hi 1.2559 Low 1.2525
USD/JPY 119.43 Hi 119.81 Low 119.40
AUD/USD 0.7445 Hi 0.7451 Low 0.7425
EUR/JPY 149.87 Hi 150.13 Low 149.81

I love the way things work right now. First, we have the statistics which may or may not create the desired view of reality. Right now the powers-that-be would like to propogate the view that the United States is competitive. This is a pretty heroic aim, given that the only thing going on in the United States right now is outsourcing and retrenchment. And then there is the little problem that the United States doesn't sell anything much to the rest of the world, with the possible exception of military equipment and a few i-pods, which in any case are made in China. We know this because there is something called the Trade Account. According to the statistics kindly provided by the people who collate this information the U.S. hasn't been able to sell anything much to the rest of the world for a very long time and the situation is DETERIORATING.

The existence of the Trade Deficit is a problem for the boys trying to present the U.S. as this competitive, cutting edge economy. But it is not a MAJOR problem. All that is required is that you create ALTERNATIVE statistics. Alternative statistics are the economic equivalent of SPIN. It's so in tune with the zeitgeist. First we have the FACTS, which we would really rather ignore, and then we have the SPIN which makes us and, more importantly the ELECTORATE, feel happy, in control and reassured about our place in the world. And so we have nice little men creating what is called the Global Competitive Index. It was necessary to create this fictious piece of pseudo-data because in reality when it comes to actually competing internationally the U.S. sucks, big time. The U.S. is running one of the biggest external trading deficits ever seen in the modern world. It also seems to have a small problem generating domestic savings, controlling its Federal Government Spending, rebuilding cities called New Orleans and controlling violence and crime.

According to the Competitive Index, however, things aren't nearly so bad. The U.S. only just dropped off the TOP SPOT. Hey, that's great !! The U.S. really is competitive. We knew it. All we had to do was create the right type of statistic to prove it. And we've done that. So let's not talk about hard data any more. The hard data is so UNINSPIRING. Let's talk about all these pseudo-numbers which are so much more pleasant. And if we can get the markets to buy into our ALTERNATIVE reality, then everything will be fine for a little while longer.

What I especially love about the current line of thinking is this: if the U.S.A. enjoys such a competitive edge compared to much of the rest of the world then why can't it run a Trade Surplus? Or at least why can't it reduce its hideous Trade DEFICIT? Something is going seriously wrong. Here is this country with this great competitive edge, fuel prices which are ONE THIRD of fuel prices in Europe, and STILL it is running an external account which makes it look like a third world nation. Now, third world nations in the throes of industrialisation sometimes suck in imports and capital in order to build an industrial base from scratch. Is this what the U.S.A. is doing without telling anyone? Sucking in money to build brand new, state-of-the-art factories and infrastructure? No, I don't think so.

I have one question: how high in the competitive rankings does the U.S.A. have to go before it can actually compete with the rest of the world? If the U.S.A. was Number One in the Global Competitive Index and STILL ran a Trade Deficit, as appears to be the case, doesn't that mean that the very significance of the word "competitive" has changed and no-one has told us?

But there is more to the alternative view of reality than simply boasting about how great things are in the United States. The same useless index can and has been used to make unpleasant comments about the economic performance of other countries. Maintaining perceptions and international confidence in the U.S.A. and the USD is soooo important when you need those capital inflows. So in a similar fashion fair and balanced publications like the London Financial Times have published misinformed letters and articles which suggest that Italy has lost its competitive edge. I like how they do this without ever mentioning the fact that Italy is NOT in fact running a major trading deficit, does not rely on foreign capital inflows and domestic savings finance an estimated 97% of its very ugly Government Debt. 97% being a conservative estimate. There are a whole lot of other statistics which need to be discussed in order to understand the Italian economy and I will do that at some later date. Needless to say that most commentators feel quite happy going with the Global Competitive Index and ignoring everything else.

Now I appreciate the urgency of the need to keep the international financial structure ticking over, I really do. However, it would be good from the perspective of good news reporting that we could at least have opinions which in some way tie in with the real world and the real data. As opposed to the alternative DATA which has been created ad hoc to present the ongoing economic decline of the United States in the best possible light.

The USD remains relatively stable following the comprehensive rebasing of the employment figures in the United States Friday. This, together with an altogether more HAWKISH tone of various FED officials has convinced the FX market that the USD is a buy. Or at least not a sell. Meanwhile the BOND market doesn't look the slightest bit pleased that the FED is coming across as gung-ho about inflation. U.S. Treasuries still look very ugly. Which kind of begs the question: if foreigners are piling into the USD what are they doing with their USDs once they get them? The answer might upset some of the people at the FED. It could be quite possible that the recent USD run-up has been entirely speculative. No real capital inflows are taking place. If that is the case the happy-clappy crowd which is fine with the positive spin on the unimpressive U.S. data might find out that holding USDs for the slightly more than 48 hour horizon is fraught with risks.

Meanwhile in the old and gloomy EuroZone recently released Industrial Production data has been positive all round. Italian industrial output rose 1.2% on the month in August and was up 3.5% on the year. There were annual increases in all sectors apart from consumer goods. French Industrial Production numbers were also positive. Industrial production in Germany came out as a positive surprise in August, thanks to an increase in manufacturing output. Industrial output grew 1.9% on the month. Figures rose 7.2% in a yearly basis, this is the strongest jump since January 1991. Similar growth was last seen in November 1994 when a 7.0% annual increase was recorded. And Trichet is starting to talk darkly about broad based economic recovery and they WILL be looking at those interest rates again.

Still the FX market has all but ignored these numbers preferring to go with the excitement about the U.S. statistical revisions. In the longer term this is unlikely to be a winning strategy.

OIL 58.22
GOLD 577.00

While the great Commodity Bubble is taking it on the chin, the downside for both OIL and GOLD have remained relatively contained. The key to GOLD is what happens to the USD. Should the USD rally, by some miracle, continue then a general unloading of GOLD can be expected.

Tuesday, October 10, 2006

Lies, Lies and Damned Statistics

EUR/USD 1.2561 Hi 1.2615 Low 1.2553
USD/JPY 119.45 Hi 119.53 Low 118.89
AUD/USD 0.7445 Hi 0.7464 Low 0.7435
EUR/JPY 150.04 Hi 150.24 Low 149.78

One set of statistics and suddenly there is no need to worry: the U.S. economy is doing just fine. The FED may be in PAUSE mode but there is no need to ease. The guys who work in the Statistics Department just found an extra 810,000 jobs. Not in September mind you. No, those came out at about 80,000 below expectations. But the real exciting news is that all the previous numbers were wrong anyway so actually things are looking pretty good. We think. Not that anyone really understands what is going on. All the explanations released have been opaque at best. And no-one is too clear about what Non Farm Payrolls are anyway. Except they are important. We think. And they give a good idea about what is happening to the economy. Maybe. Oh and employment is a lagging indicator anyway, which means that you can't really gauge what is going on in the economy by watching employment numbers. What you have to watch are the leading indicators. Things like credit growth. No matter.

The only thing the market knows is that BEFORE this data was released the whole world was waiting for the FED to announce a move towards monetary policy easing. Well not really but still the general idea was that an EASE was reasonable response to falling housing sales and prices, falling leading economic indicators, and a Philly Fed index which had the first negative reading in three years. Not to mention that the American consumer is already up to his eyeballs in debt, that online and newspaper advertising revenue are down, the Help Wanted Index is down. Oh and Factory Orders look weak, the yield curve is still negative and the word RECESSION is starting to make the rounds.

So armed with the NEW VIEW that rates in the States are on HOLD, the USD was bid Friday. And it remains reasonably bid. Now we have the big test. Can the market push on with the USD rally in the face of an overall outlook for the U.S. economy which has not changed? Even with an election on November 7, little more than happy window dressing is likely. For now the answer is yes. Yes buy Stocks, buy the USD and sell BONDS. The big new trend is the BOND market bear story. This one should be watched.

Meanwhile back in EuroZone Land on Thursday last week Trichet pretty much ruled out anything more than another 25 point hike in interest rates for 2006. Trichet suggested that monetary policy in the EuroZone remains accommodative but that longer term risks to economic growth are all to the downside. And those risks are ALL EXTERNAL.

Risk N°1: the OIL price. Risk N°2: the risk to international trade from protectionism. Risk N°3: existing current account imbalances. So, according to Trichet, growth in Europe could dive on another hike in OIL prices. Nothing new there. The other risk, according to Trichet, is that some countries will attempt to address their trade problems and current account imbalances in some unfortunate manner. And the country at the centre of these "Trade and Current Account Imbalances" is the United States which could, presumably, either attempt to close its markets to international trade or try to address the problem by engineering a USD devaluation.

Otherwise Trichet was fairly nonchalant about the impact of a possible U.S. economic recession on European economic growth. A 1% fall in economic activity in the USA would, according to his calculations, only reduce European growth by 0.2% or so. So right now there doesn't appear to be a huge concern in the EuroZone about the possibility that the U.S.A. slides into recession. Provided, of course, that it does not make ugly policy choices as a result. Trichet even joked that what happens in the U.K. is more significant for the EuroZone than what happens in the States. So for now the ECB is happy to go with another rate hike by the end of the year, though not at the next meeting, which would take short term rates to 3.5%. After that it's approach will be: wait and see. And what they will be waiting and seeing for will be the global economic environment.

The ECB certainly seems to have lost its hawkish tone. And, indeed, Trichet suggested that inflation could fall sharply at year end. So, although the reality on the ground remains pretty much unchanged, the fact that the ECB is no longer talking extreme vigilance and rate hikes into 2007 represents the news the market is happy to trade on.

GOLD 582.80
OIL 59.95

GOLD hasn't seen much in the way of selling pressure following the NFP numbers released Friday, despite the USD rally which followed. Buying interest remains solid.

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